THE FINANCIAL PAGE THE UR.GE TO MER.GE O ne December night a hundred and one years ago, the financier J. Morgan sat in the University Club of New York and listened attentively as Charles Schwab, the president of Carne- gIe Steel, expounded on the future of the steel industry: Carnegie Steel was already the biggest and most efficient steehnaker in the world, but Schwab argued that it was not big enough. Only if the various warring steel companies consolidated into one giant firm would they be able to reap the benefits of modem management and technology. The path to success was not competition but acquisition. Morgan, who owned Federal Steel, liked the sound of this, since competition, in his view, bred chaos and inefficiency: A few weeks later, he met with Schwab to talk about buying Carnegie Steel. Schwab consulted with Andrew Carnegie, who scribbled "$480 million" on a sheet of paper. Pre- sented with it, Morgan said simply; "I accept this price," and U.S. Steel, the world's largest corporation, was born. In the century since, thousands of C.E.O.s have fancied themselves Mor- gans-in-the-making, shelling out tril- lions of dollars in a quest to gorge their way to greatness. Buying yourself an empire is as American as starting one in your garage. During the Jazz Age, forty- nine of the country's biggest corpora- tions disappeared through mergers. In the nineteen-sixties, a fifth of the com- panies in the Fortune 500 were acquired. And between 1997 and 2000 no fewer than thirty-four thousand companies were gobbled up. The latest glutton is Car1y Fiorina, the C.E.O. of Hewlett Packard. Last week, she announced that H. would spend twenty-five billion dollars to acquire Compaq Computer one of H. 's big- gest competitors. Both H. and Com- paq have struggled during the economic slowdown of the past year. But Fiorina insisted that uniting the two firms would solve their problems, creating a company with the size and scope to dominate ex- isting markets and make a splashy entry into new ones. This was about as smart as betting all your money on a long shot 72 THE NEW YORKER, SEPTEMBER 17 2001 after a bad day at the track, which is why investors have been punishing H. 's stock since the deal was announced. Fiorina arrived at H. from Lucent two years ago, amid great fanfare. (Her timing was impeccable; following her departure, Lucent fell to pieces.) Young, poised, and tough-minded, she vowed to restore H. to greatness, virtually over- night. H. , she urged, had to adopt a crisis mentality. But H. wasn't facing a crisis. Though sprawling and slug- gish, it was still comfortably profitable. It had problems, but they were long-term problems that would take years, not months, to fix. Fiorina didn't pick up on this. Even after the economy started to falter, she kept making outlandish prom- .". ";(';-. .':' ' .." . ..; . . ..;..: ..; .: ;': ':'>>:'- . . :':':':':';'. ..,:.:o-.. .n-- . . e-- ... ' ises, which kept not coming true. In each of the last three quarters, H. missed analysts' earnings estimates. Fiorlna lost credibility on Wall Street. Shareholders .I started to grumble. In other words, it seemed like the per- fect time for a conspicuous, expensive ac- quisition. Much as Michael Armstrong tried, disastrously, to stem A. T & T.'s steady decline by buying two cable com- panies (at a cost of a hundred billion dol- lars), Fiorina wants to jolt H.E out of its funk--and restore her own reputation- by buying Compaq. Misery, it seems, loves companies. Fiorina clearly believes that she can do great things for Compaq. In this, she is like most C.E.O.s who make costlyac- quisitions. As Warren Buffett wrote in a 19811etter to shareholders, "Many man- agements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad's body by a kiss from a beautiful princess." Compaq is a slow-growing, unprofitable company in a stagnant industry: Alas, it's a toad that's going to stay a toad. Yet even if Compaq were in fine shape, spending twenty-five billion dol- lars on it would probably be a bad idea. That's because most mergers don't work The economist Mark Sirower, in his book "The Synergy Trap," demonstrated that two-thirds of all acquisitions end up representing a loss of value for the ac- quirer. Companies routinely underesti- mate just how hard it is to make one company out of two. And they overesti- mate the difference that they'll make to their new mates. H. is paying twenty per cent more for Compaq than investors thought it was worth. To justifY this pre- mium, Fiorina will. have to make H.E and Compaq twenty per cent more prof- itable than they are today--a tall order, in slow times such as these. The corporate faith in big industrial mergers is a vestige of the spats-and- spittoon era. A century ago, only a few corporations were national in scope, so acquiring companies was a sensible way to get into markets you otherwise couldn't reach. And, in the early days of mass production, size mattered. It created economies of scale; the more you made, the cheaper it was to make it. Today; a company like H. can get into any mar- ket it wants. And it's already so big that economies of scale don't apply: Even in 1901, a merger was no panacea. When U.S. Steel was chartered, it had a commanding share of the steel market. A decade later, its market share had shrunk, and it had grown fat and 1aZ)T. New competitors sprang up. By the late twenties, it had been eclipsed tech- nologically by nimbler rivals. And, while C.E.O.s may spend a lot of time, energy, and shareholder money trying to turn themselves into J. E Morgan, they forget one thing. It was Andrew Carnegie-the guy selling the company; not the guy buy- ing it-who emerged from that deal as the richest man on earth. -James Surowiecki z z w Z I c.... o l- t/) ëi2 I U